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THE  CHICAGO  &  ALTON  CASE 

A  MISUNDERSTOOD  TRANSACTION 


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The 

Chicago  &  Alton 

Case 

A  Misunderstood  Transaction 
By  George  Kennan 


The  Country  Life  Press 

Garden  City,  New  York 


•55* 


^VCfAr 


Copyright,  1916,  by 

jj  GEORGE  KENNAN 


-  . 


THE  CHICAGO  &  ALTON  CASE 

A  MISUNDERSTOOD  TRANSACTION 


323588 


The  Chicago  and  Alton  Case: 
A  Misunderstood  Transaction 

No  episode,  perhaps,  in  the  career  of  the  late 
E.  H.  Harriman  has  been  more  severely  criti- 
cised by  the  Interstate  Commerce  Commission, 
by  certain  members  of  Congress,  and  by  an 
ill-informed  part  of  the  public  than  the  re- 
organization of  the  Chicago  &  Alton  Railroad 
in  1899  and  1900,  It  excited  little  comment  at 
the  time,  but  when,  long  afterward,  the  Gov- 
ernment began  its  campaign  against  Mr.  Har- 
riman, through  the  Interstate  Commerce  Com- 
mission, the  transaction  was  characterized  as 
"indefensible  financing,"  and  was  described 
as  the  "crippling,"  "looting,"  and  "scuttling" 
of  a  well-managed  and  prosperous  railroad  by  a 
syndicate  of  unscrupulous  financiers  in  which 
Mr.  Harriman  was  the  "main  conspirator."1 

The  Chicago  &  Alton  Railroad,  when  Mr. 
Harriman  became  connected  with  it,  was  an 

xReports  of  the  Interstate  Commerce  Commission,  Vol.  XII, 
pp.  301-303;  statement  of  Senator  Cullom,  New  York  Inde- 
pendent, Vol.  LXII,  p.  692;  "Railroads:  Finance  and  Organi- 
zation," by  Prof.  W.  Z.  Ripley,  pp.  262-267.    N.  Y.,  1915. 


THE  CHICAGO  AND  ALTON  CASE 

apparently  prosperous  and  well-managed  road. 
It  had  paid  dividends  of  8  per  cent,  on  its  in- 
vested capital  for  thirty  years  or  more;  its 
credit  was  good,  and  its  shares  of  common  and 
preferred  stock  were  selling  at  from  75  to  100 
points  above  their  par  value.  From  a  financial 
point  of  view,  it  seemed  to  be  as  strong  as  any 
railroad  of  its  class  in  the  Middle  West.  Un- 
fortunately, however,  its  managers  had  pursued 
an  ultra-conservative  policy  in  the  matter  of 
expenditures,  and  had  neglected,  for  a  long 
time,  to  make  necessary  appropriations  to 
cover  depreciation,  and  to  provide  for  exten- 
sions, betterments,  replacements,  and  addi- 
tional equipment.  The  road  had  grown  old 
without  improving  in  physical  condition;  and 
had  become  more  or  less  incapable  of  rendering 
the  service  demanded  by  a  rapidly  growing  and 
developing  territory.  Speaking  of  this  state  of 
affairs,  the  well-known  economist,  Prof.  E.  S. 
Mead,  says: 

"The  condition  of  the  Alton  was  far  below 
that  of  its  competitors.  The  standards  of 
construction  were  those  of  fifteen  years  before. 
The  track  was  laid  with  steel  rails,  but  these 
were  only  seventy  pounds  to  the  yard.  The 
bridges  were  in  good  condition,  but  were  too 
light  for  heavy  engines.    The  capacity  of  the 


A  MISUNDERSTOOD  TRANSACTION 

sidings  and  second  track  was  inadequate  to 
handle  large  increase  of  traffic.  In  short,  the 
company  had  not  maintained  a  sufficient  de- 
preciation account,  and  its  property  had  not 
been  kept  up  to  standard."1 

According  to  J.  H.  McClement,  expert  ac- 
countant, who  had  occasion  to  investigate  the 
affairs  of  the  company: 

"It  had  not  added  one  mile  of  road  in  seven- 
teen years.  It  had  little  or  no  reserve  capacity 
to  conduct  a  larger  business.  Its  cost  of  opera- 
tion, per  unit  of  traffic,  was  very  high  in  com- 
parison with  similar  roads.  Its  grades  were 
uneconomical.  Its  shops  and  equipment  were 
uneconomical  and  old.  Its  settled  policy  against 
the  expansion  of  its  facilities,  because  of  de- 
clining rates,  was  an  absolute  bar  to  the  de- 
velopment of  the  tributary  country.  While 
for  twenty-five  years  it  had  paid  an  average 
dividend  of  8.3  per  cent,  on  its  capital  stock,  the 
gross  earnings  for  the  year  1898" — (the  year 
before  Mr.  Harriman  became  interested  in  it) 
— "amounting  to  $6,286,000,  were  the  lowest 
since  1880,  and  had  been  gradually  falling  since 
1887,  when  they  amounted  to  $8,941,000.  In 
many  respects  the  company  was  being  con- 
ducted like  a  commercial  enterprise  having  in 

^'Corporation  Finance,"  by  Edward  Sherwood  Mead,  Ph.  D., 
Wharton  School  of  Finance  and  Commerce,  University  of  Penn- 
sylvania, pp.  252-253.    N.  Y.,  1914. 


THE  CHICAGO  AND  ALTON  CASE 

view  ultimate  liquidation,  instead  of  like  a 
public  carrier."1 

The  ultra-conservative — not  to  say  parsi- 
monious— policy  of  the  management,  the  pro- 
gressive deterioration  in  the  physical  condition 
of  the  road,  and  the  decline  of  $2,655,000  in 
annual  earnings  in  a  period  of  eleven  years,  nat- 
urally created  dissatisfaction  and  excited  a 
feeling  of  uneasiness  among  the  owners  of  the 
company's  securities;  and  in  the  fall  of  1898  a 
number  of  the  large  stockholders,  actuated  by  a 
feeling  of  apprehension  as  to  the  future  of  the 
road,  requested  John  J.  Mitchell,  President  of 
the  Illinois  Trust  Company,  to  open  negotia- 
tions with  Mr.  Harriman,  with  a  view  to  the 
sale  of  the  property  and  a  financial  reorganiza- 
tion of  the  company.2 

Mr.  Mitchell  had  an  interview  with  Mr. 
Harriman  in  New  York,  and  represented  to 

'"Statement  of  the  Recapitalization  of  the  Chicago  &  Alton 
Railroad  Company,"  by  J.  H.  McClement,  Expert  Accountant. 
N.  Y.,  1907. 

2Among  the  prominent  stockholders  of  the  Chicago  &  Alton  at 
this  time  were  Morris  K.  Jessup  of  New  York,  Marshall  Field  of 
Chicago,  John  A.  Stewart  of  New  York  (President  of  the  U.  S. 
Trust  Company  and  formerly  Assistant  Treasurer  of  the  United 
States),  Albert  A.  Sprague  (of  Sprague  Warner  &  Co.,  Chicago), 
A.  C.  Bartlett  (Vice-President  of  Hibbard,  Spencer,  Bartlett 
&  Co.,  Chicago),  and  John  J.  Mitchell  (President  of  the  Illinois 
Trust  Company).  These  were  not  men  likely  to  be  hoodwinked 
or  deceived  by  "unscrupulous  financiers"  bent  on  wrecking  the 
Alton  road. 


A  MISUNDERSTOOD  TRANSACTION 

him  that  "many  of  the  Alton  stockholders 
were  dissatisfied  with  the  existing  management; 
that  the  stock  might  be  bought  for  less  than  the 
real  value  of  the  property;  that  if  betterments 
and  improvements  were  made  and  modern 
methods  introduced  the  earnings  might  be 
largely  increased,  and  that  if  control  of  the 
road  were  purchased,  if  funds  for  such  better- 
ments were  provided,  and  if  the  road  were 
developed,  there  would  be  an  opportunity  for  a 
substantial  profit." 

Mr.  Harriman,  who  had  never  before  thought 
of  purchasing  the  Chicago  &  Alton,  told  Mr. 
Mitchell  that  he  would  take  the  matter  into 
consideration,  and  ascertain  as  soon  as  possible 
the  condition  of  the  road.  Shortly  after  this 
interview  Mr.  Harriman  requested  Mr.  S.  M. 
Felton,  a  well-known  expert  and  railroad 
manager,1  to  make  a  thorough  examination  of 
the  property  and  submit  a  detailed  report  on  its 
condition,  requirements,  and  earning  capacity. 
Mr.  Felton's  report  was  favorable.  He  esti- 
mated that  better  management,  and  the  ex- 


*Mr.  Felton  had  had  long  and  varied  railroad  experience  as 
Chief  Engineer  of  the  Chester  &  Delaware  River  Railroad; 
General  Superintendent  of  the  P.  C.  &  St.  L.;  General  Manager 
of  the  N.  Y.  &  N.  E.;  Vice-President  of  the  Erie,  of  the  East  Tenn., 
Va.  &  Ga.  system,  of  the  Memphis  &  Charleston,  and  of  the  Mobile 
&  Birmingham;  and  President  of  the  Alabama  Great  Southern, 
and  of  the  N.  0.  &  Texas  Pacific. 


THE  CHICAGO  AND  ALTON  CASE 

penditure  of  $5,200,000  for  improvements  and 
additional  equipment  would  enable  the  road  to 
increase  its  earnings  by  at  least  $1,000,000  a 
year  on  the  traffic  then  existing,  to  say  nothing 
of  the  increased  traffic  that  might  be  expected 
when  the  road  should  be  able  to  afford  adequate 
f  acilities  to  the  then  rapidly  developing  territory 
that  it  served. 

Becoming  satisfied  that  the  road  could  be 
bought  for  less  than  its  potential  value,  Mr. 
Harriman  invited  Jacob  H.  Schiff  (of  Kuhn 
Loeb  &  Co.),  James  Stillman  (President  of  the 
National  City  Bank),  and  George  Gould  to 
join  him  in  making  the  purchase  on  the  terms 
suggested,  and  in  providing  the  necessary  funds 
for  betterments  and  additional  equipment,  as 
well  as  for  the  refunding  or  retirement  of  the 
company's  maturing  bonds.  Upon  the  repre- 
sentations made  by  Mr.  Harriman,  Messrs. 
Schiff,  Stillman,  and  Gould  agreed  to  co6perate 
with  him,  and  the  four  men  formed  a  syndicate 
for  the  purchase,  reorganization,  and  recapitali- 
zation of  the  Chicago  &  Alton  road. 

This  syndicate  was  ultimately  made  to  include 
Morris  K.  Jessup,  John  A.  Stewart  (ex- Assistant 
Treasurer  of  the  United  States),  John  J.  Mitchell 
(President  of  the  Illinois  Trust  Company),  and 
other  individuals  of  like  character,  as  well  as 

8 


A  MISUNDERSTOOD  TRANSACTION 

some  of  the  leading  financial  houses  and  insti- 
tutions of  the  country.  The  supposition  that 
men  and  firms  of  such  standing  would  join  a 
band  of  "pirates"  and  "looters"  for  the  purpose 
of  "wrecking"  and  "gutting"  the  Alton  is,  to 
say  the  least,  highly  improbable.  The  public 
assumed,  or  was  led  to  believe,  that  Messrs. 
Harriman,  Stillman,  Schiff ,  and  Gould  were  the 
sole  managers  and  beneficiaries  of  the  reorgani- 
zation; but  this  was  not  the  case.  The  four 
gentlemen  named  organized  the  syndicate,  but 
it  included  about  one  hundred  members. 

In  January,  1899,  the  syndicate  purchased 
97  per  cent,  of  the  capital  stock  of  the  Chicago 
&  Alton  Company  (about  218,000  shares)  and 
paid  therefor  the  sum  of  $38,815,000  in  cash. 
They  then  proceeded  to  readjust  the  accounts 
of  the  company  by  crediting  to  surplus  the 
sum  of  $12,444,000,  which  the  old  managers  of 
the  road,  in  previous  years,  had  taken  out  of 
current  income  and  invested  in  permanent 
betterments.  In  the  opinion  of  the  new  owners 
and  their  legal  counsel,  permanent  improve- 
ments and  additions  to  the  property  ought  to 
have  been  charged  to  capital  account,  and  not 
taken  out  of  surplus  earnings,  which  belonged 
to  the  stockholders  and  might  properly  have 
been    distributed    in    dividends.    The    newly 


THE  CHICAGO  AND  ALTON  CASE 

elected  directors,  therefore,  charged  to  capital 
the  sum  of  $12,444,000  previously  spent  in 
betterments,  and  credited  it  to  surplus,  with  a 
view  to  distributing  a  part  of  it  ($6,669,000) 
in  the  shape  of  a  30  per  cent,  dividend  on  the 
old  stock,  and  so  lessening  the  cost  of  the  road 
to  its  purchasers.  ] 

Having  thus  acquired  the  property,  and 
transferred  the  cost  of  previous  betterments  to 
capital  account,  the  syndicate,  which  included 
97  per  cent,  of  the  stockholders,  reorganized 
the  corporation  and  elected  as  President  Mr. 
S.  M.  Felton,  upon  whose  report  the  road  had 
been  bought.  They  then  recapitalized  the 
company  by  issuing  securities  in  the  following 
amounts: 

50-year  3  per  cent,  bonds     ....     $31,988,000* 


50-year  2>2  Per  cent-  bonds 
4  per  cent,  preferred  stock 
Common  stock 


Total 


22,000,000 
19,544,000 
19,542,000 

$93,074,000 


The  $31,988,000  of  3  per  cent,  bonds  actually 
issued  were  offered  to  all  the  stockholders  and 


^orty  millions  in  3  per  cent,  bonds  were  authorized,  but 
$8,012,000  were  held  in  reserve  for  future  requirements.  These 
eight  millions  were  subsequently  sold  at  market  rates,  and  the 
proceeds  were  spent  on  the  property. 

IO 


A  MISUNDERSTOOD  TRANSACTION 

taken  by  them  pro  rata,  at  65,  which  was  be- 
lieved at  the  time  and  in  the  circumstances  to 
be  a  fair  rate.  The  purchase  of  these  securities 
at  a  cost  of  $20,792,200,  and  the  acquirement  of 
97  per  cent,  of  the  stock  of  the  old  company  at  a 
cost  of  $38,815,000,  made  the  investment  of  the 
syndicate  in  the  reorganized  road  $59,607,200. 
This  sum  was  soon  afterward  increased  by  the 
purchase  of  the  Peoria  Northern  Line  at 
$3,000,000,  and  the  payment  of  $500,000  for 
commissions,  charges,  legal  expenses,  etc.,  in 
connection  with  the  reorganization.  This  made 
the  total  investment  of  the  new  owners  of  the 
road  $63,107,200,  as  shown  below: 

Purchase  of  97  per  cent,  of  the  old  com- 
pany's stock $38,815,000 

Purchase  of  $31,988,000  3  per  cent,  bonds 
at  65        20,792,200 

Purchase  of  Peoria  Northern  Line       .        3,000,000 

Commissions,  legal  expenses,  etc.    .     .  500,000 

Total $63,io7,2oo1 

As  soon  as  the  sale  of  the  bonds  put  sufficient 
money  into  the  treasury  and  made  available 

lIt  is  quite  possible  that  the  syndicate  did  not  have  this  whole 
amount  invested  at  any  one  time,  because  some  of  the  securities 
may  have  been  sold  before  the  transaction  was  completed.  The 
figures  are  given  in  this  way  only  for  the  purpose  of  showing  how 
much  money  the  stockholders  put  into  the  venture  from  first 
to  last. 

II 


THE  CHICAGO  AND  ALTON  CASE 

the  $12,444,000  of  surplus  created  by  capitaliz- 
ing the  sums  previously  spent  in  betterments, 
the  new  directors  declared  a  cash  dividend 
of  30  per  cent,  on  the  old  company's  stock,  for 
the  purpose  of  lessening  the  cost  of  the  road  to 
its  buyers.  This  reduced  the  sum  of  their 
investment  as  follows: 

Total  cost  of  the  road  to  its  purchasers 

(as  shown  above)    ......     $63,107,200 

Less  dividend  of  30  per  cent,  on  the  old 
stock 6,669,180 

Reduced  cost         $56,438,020 

To  represent  this  investment,  the  new  stock- 
holders had  in  hand,  for  sale  at  the  best  prices 
they  could  get: 

3  per  cent,  bonds,  par  value  .  .  .  $31,988,000 
3 J  per  cent,  bonds,  par  value    .     .     .  22,000,000 

4  per  cent,  preferred  stock,  par  value.  19,544,000 
Common  stock  par  value       .     .     .  19,542,000 

Total $93,o74,ooo1 

In  order  to  get  back  the  amount  that  they 
had  actually  put  into  the  property  ($56,438,020 
as  above  shown)  the  stockholders  would  have  to 

^his  capitalization  was  increased  to  $101,086,000  when  the 
reserved  bonds  ($8,012,000)  were  issued.  The  total  of  3  per  cent, 
bonds  was  then  $40,000,000  instead  of  $31,988,000,  as  here 
stated. 

12 


A  MISUNDERSTOOD  TRANSACTION 

sell  the  bonds  and  preferred  stock  at  approxi- 
mately the  following  figures : 

$31,988,000  3  per  cent,  bonds  at  80  .  $25,590,400 
22,000,000  3!  per  cent,  bonds  at  74  .  16,280,000 
19,544,000  preferred  stock  at  75         .       14,658,000 

Total $56,528,400 

Money  invested 56,438,020 

They  would  then  have  the  common  stock  as 
clear  profit,  and  if  they  sold  it  at,  say,  25,  they 
would  make  about  $5,000,000  on  the  purchase 
and  recapitalization  of  the  road.  This  would 
be  equivalent  to  about  9  per  cent,  on  their 
total  investment.  They  perhaps  made  more 
than  this,  but  how  much  more  it  is  impossible 
to  determine.  After  the  securities  were  dis- 
tributed among  the  members  of  the  syndicate 
they  were  sold  by  the  individual  owners  at 
various  prices,  and  at  various  times  between 
1900  and  1907.  The  profit  realized  depended, 
in  every  case,  upon  market  conditions  at  the 
date  of  sale.  Professor  Ripley  states,  as  a 
fact,  that  the  profits  of  the  syndicate — that  is, 
of  the  one  hundred  or  more  stockholders — 
were  $23,600,000;  but  as  he  does  not  give  his 
method  of  computation  there  is  no  possibility 
of  testing  his  results.    The  Attorney-General 

13 


THE  CHICAGO  AND  ALTON  CASE 

of  Illinois  figured  that  the  syndicate  made  a 
profit  of  $24,648,600;  but  his  calculations  were 
soon  discredited.  Expert  Accountant  J.  H. 
McClement  showed  that  even  accepting  the 
inordinately  high  prices  at  which  the  Attorney- 
General  assumed  the  stockholders  sold,  their 
profit  was  only  $11,124,300.  In  other  words, 
the  figuring  did  not  work  out.1 

As  a  matter  of  fact,  the  computations  of  both 
Ripley  and  the  Attorney-General  were  mere 
guesses,  made  under  the  influence  of  a  strong 
anti-Harriman  bias.  If  the  stockholders  sold 
their  securities  at  the  average  prices  that  pre- 
vailed between  1901  and  1907,  they  made 
$7,624,000.  If  they  sold  in  the  summer  of 
1903,  when  the  control  of  the  road  was  acquired 
by  the  Rock  Island,  they  made  $2,800,000. 
If  they  held  on  until  1907,  and  sold  then,  they 
lost  $i,40o,ooo.2  The  probability  is  that 
most  of  the  stockholders  sold  at  the  most 
favorable  time — i.  e.,  in  the  first  year,  or  the 
first  two  years,  after  the  securities  were  dis- 
tributed. By  an  Act  of  the  New  York  Legis- 
lature, approved  February  26,  1900,  the  3  per 
cent,  bonds  of  the  Alton  road  were  made  a 


^'Statement  of  the  Recapitalization  of  the  Chicago  &  Alton 
Railroad  Company,"  pp.  13-14-    N.  Y.,  1907. 
2McClement :  pp.  13-14  et  seq.    . 

14 


A  MISUNDERSTOOD  TRANSACTION 

legal  investment  for  the  savings  banks  of  that 
state,  and  this  immediately  created  a  good 
demand  for  them  at  prices  which  ranged  from 
82^  to  94.  As  there  is  no  means,  however,  of 
ascertaining  when  the  hundred  or  more  stock- 
holders disposed  of  their  holdings,  nor  what 
prices  they  obtained  for  them,  it  is  impossible 
to  know  what  their  profits  were;  and  for  that 
reason  all  estimates  are  more  or  less  conjectural. 
The  most  that  can  be  said  with  certainty  is  that 
owing  to  favorable  market  conditions,  those  who 
happened  to  sell  at  top  prices  realized  more  than 
they  had  anticipated. 

A  prominent  New  York  banking  house  which 
had  no  connection  with  the  Chicago  &  Alton 
transaction,  except  that  it  participated  to  the 
extent  of  $250,000  in  the  investment,  was  asked 
recently  to  look  up  its  records  and  find  out  what 
its  profits  were.  The  value  of  its  participation, 
and  of  the  securities  represented  thereby,  varied 
from  time  to  time  according  to  the  market  value 
of  the  securities.  There  were  times  when  the 
transaction  showed  little  or  no  profit.  The 
maximum  profit  that  it  showed  at  any  one  time 
was  about  8.2  per  cent.  The  impression  of  these 
bankers  is  that  if  a  participant  got  out  at  the 
most  favorable  time,  he  made  a  profit  of  about 
9  per  cent.     The  result  of  the  reorganization, 

15 


THE  CHICAGO  AND  ALTON  CASE 

so  far  as  the  stockholders  are  concerned,  may 
be  summarized  in  the  statement  that  they  in- 
vested $56,000,000  or  $57,000,000  in  the  prop- 
erty (including  the  purchase  of  the  3  per  cent, 
bonds),  expanded  the  capitalization  by  issuing 
new  securities  to  the  par  value  of  $93,074,000 
(excluding  the  $8,012,000  held  in  reserve  for 
betterments),  and  finally  sold  these  securities 
at  prices  which  gave  them  a  net  profit  of  prob- 
ably 8  per  cent.,  and  possibly  12  or  15  per  cent., 
upon  their  total  cash  investment. 

At  the  time  when  the  road  changed  owner- 
ship, the  series  of  transactions  above  outlined 
excited  little  if  any  adverse  criticism.  Every 
detail  of  the  reorganization,  including  the  30  per 
cent,  dividend  and  the  sale  of  the  3  per  cent, 
bonds  to  the  new  stockholders  at  65,  had  the 
widest  possible  publicity;  but  nobody  com- 
plained of  injury  or  injustice.  The  former 
owners  of  the  road  were  satisfied  with  the  price 
that  they  received;  the  3  per  cent,  of  the  old 
stockholders  who  declined  to  sell  their  shares 
enjoyed  precisely  the  same  rights  and  privileges 
that  were  given  to  the  new  stockholders;  the 
purchasers  of  the  new  securities  bought  with 
full  knowledge  of  the  syndicate's  operations, 
and  did  not  complain  that  they  had  been  either 
misinformed  or  misled;  the  governors  of  the  New 

16 


A  MISUNDERSTOOD  TRANSACTION 

York  Stock  Exchange  considered  all  the  details 
of  the  recapitalization  and  then  listed  the  new 
securities  without  objection  or  question;  and, 
finally,  the  patrons  of  the  road — the  farmers, 
manufacturers,  and  shippers — were  more  than 
satisfied  with  the  lower  rates  and  greatly  in- 
creased facilities  that  they  enjoyed  under  the 
new  management. 

Serious  and  hostile  criticism  of  the  Chicago 
&  Alton  reorganization  did  not  begin  until  1906 
— seven  years  after  the  Harriman  syndicate 
bought  the  road.  In  the  fall  of  that  year  the 
friendly  relations  that  had  previously  existed 
between  President  Roosevelt  and  Mr.  Harriman 
were  broken  off,  as  the  result  of  a  disagreement, 
or  misunderstanding,  with  regard  to  a  contri- 
bution made  by  Mr.  Harriman  to  the  Republi- 
can campaign  fund  just  prior  to  the  Presidential 
election  of  1904.  Mr.  Harriman  thought  that 
the  President  had  failed  to  observe  the  terms  of 
a  mutual  understanding  with  reference  to  the 
best  means  of  promoting  the  interests  of  the 
party  in  New  York;  and  when,  in  the  fall  of 
1906,  he  was  asked  by  James  S.  Sherman, 
Chairman  of  the  Republican  Congressional 
Committee,  to  contribute  again,  he  declined 
to  do  so,  for  the  alleged  reason  that  the  Pres- 
ident had  not  kept  faith  with  him.     His  refusal 

17 


THE  CHICAGO  AND  ALTON  CASE 

was  made  known,  of  course,  to  Mr.  Roosevelt — 
perhaps  with  an  unfair  or  inaccurate  statement 
of  the  reasons  for  it — and  the  President,  resent- 
ing the  imputation  of  unfaithfulness,  assumed 
toward  Mr.  Harriman  an  attitude  of  hostility, 
and  finally  characterized  him,  in  a  letter  to 
Representative  Sherman,  as  an  "undesirable 
citizen."1 

Five  or  six  months  later — in  April,  1907 — 
a  discharged  stenographer,  who  had  formerly 
been  employed  by  Mr.  Harriman,  dishonorably 
sold  to  the  New  York  World  an  imperfect  copy 
of  a  private  letter  written  by  Mr.  Harriman  to 
one  Sidney  Webster  of  New  York.  In  this 
letter  Mr.  Harriman  set  forth  his  understanding 
of  the  campaign-contribution  episode,  together 
with  his  reasons  for  believing  that  the  President 
had  treated  him  unfairly.  The  publication  of 
this  letter  led  to  a  somewhat  acrimonious 
newspaper  controversy,  in  which  the  President 
denied  and  Mr.  Harriman  reaffirmed  the  ac- 
curacy of  the  statements  made  therein.2 

It  may  be  only  a  chronological  coincidence, 
but  it  was  in  November,  1906,  immediately 
after  the  rupture  of  friendly  relations  between 


xLetter  of  President  Roosevelt  to  James  S.  Sherman,  dated 
October  8, 1906. 

2New  York  World  of  April,  2, 1907,  and  subsequent  dates. 

18 


A  MISUNDERSTOOD  TRANSACTION 

the  President  and  Mr.  Harriman,  that  the  Inter- 
state Commerce  Commission,  acting  either  on 
its  own  initiative  or  upon  suggestion,  began  its 
investigation  of  the  "undesirable  citizen's"  past 
activities;  and  it  was  on  the  5th  of  April,  1907, 
three  days  after  the  publication  of  the  Webster 
letter,  that  the  completed  case  was  submitted 
to  the  Commission  for  decision.1  The  investi- 
gation covered  of  course  the  Chicago  &  Alton 
case,  and  the  report  thereon  described  the  re- 
organization as  "indefensible  financing."  The 
features  of  the  transaction  most  severely  criti- 
cised were  the  dividend  of  30  per  cent,  on  the 
stock  of  the  old  company,  the  selling  of  the 
3  per  cent,  bonds  to  the  new  stockholders  at 
65,  and  the  alleged  "watering"  of  the  original 
stock  by  increasing  the  number  of  shares  with- 
out adding  to  the  physical  assets  of  the  road  a 
sum  equal  to  the  increase  of  capitalization. 
It  will  be  most  convenient,  perhaps,  to  take  up 
these  transactions  in  the  order  in  which  they 
have  been  mentioned. 

1.  The  30  per  cent,  dividend. 

That  the  new  stockholders  had  a  legal  right 
to  charge  to  capital  the  cost  of  permanent 

x"  Combinations  and  Consolidations  of  Carriers."  Investi- 
gation begun  November  15,  1906;  case  submitted  Aprils,  1007; 
case  decided  July  n,  1907.  Reports  of  the  Commission,  Vol. 
XII,  p.  277.    Washington,  1908. 

19 


THE  CHICAGO  AND  ALTON  CASE 

betterments  which  had  previously  been  charged 
to  income  is  unquestionable.  The  practice 
had  not  only  the  approval  of  expert  account- 
ants, but  the  sanction  of  the  courts.  In  a  pre- 
cisely similar  case  in  England  the  High  Court  of 
Appeal  said: 

"The  circumstance  that  they  had  been  paying 
what  ought  to  be  charged  to  capital  out  of 
revenue  does  not  prevent  their  right,  or  their 
duty  to  the  persons  who  are  looking  for  their 
payment  out  of  revenue,  to  credit  back  to 
revenue  those  things  which  have  been  carried, 
for  the  time  being,  to  capital  account."1 

The  new  stockholders  also  had  a  legal  right 
to  transform  the  book  surplus  thus  obtained 
into  an  actual  cash  surplus,  by  selling  bonds 
to  the  necessary  amount,  and  then  to  declare  a 
cash  dividend  from  the  surplus  so  obtained. 
W.  W.  Cook,  the  standard  authority  on  cor- 
poration law,  says: 

"When  the  company  has  used  profits  for  im- 
provements, it  may  lawfully  borrow  an  equiva- 
lent sum  of  money  for  the  purpose  of  a 
dividend.  And  it  may  properly  borrow  money 
for  a  dividend,  if  upon  a  fair  estimate  of  its 
assets  and  liabilities  it  has  assets  in  excess  of 


Mils  vs.  Northern  Railway  &  Co.  5  Chancery  Appeals  621. 
20 


A  MISUNDERSTOOD  TRANSACTION 

its  liabilities,  and  capital  stock  equal  to  the 
amount  of  the  proposed  dividend." 1 

In  paying  a  dividend  of  30  per  cent,  out  of 
a  surplus  created  by  capitalizing  the  cost  of 
previous  betterments,  the  new  management  was 
only  doing  what  the  old  management  had 
intended  to  do.  In  a  circular  letter  to  the  old 
stockholders,  written  in  February,  1899,  T.  B. 
Blackstone,  then  President  of  the  Chicago  & 
Alton  Railroad,  said: 

"In  case  a  majority  of  the  shares  of  the  com- 
pany are  not  sold  to  the  syndicate,  I  shall  advise 
that  you  authorize  the  refunding  of  the  out- 
standing bonds  of  the  company,  and  the  issue 
of  a  stock  dividend  to  represent  earnings  hereto- 
fore invested  in  permanent  improvements." 

His  reasons  for  making  this  recommendation 
were  not  only  that  large  sums  had  previously 
been  expended  in  permanent  improvements, 
which  ought  to  have  been  charged  to  capital, 
but  that,  as  a  result  of  this  policy,  the  exist- 
ing capitalization  (bonds  and  stock  together) 
represented  less  than  60  per  cent,  of  the  actual 
cost  of  the  property.2 


^ook  on  "  Corporations,"  5th  edition,  section  546. 
2Report  of  President  Blackstone  for  1894. 

21 


THE  CHICAGO  AND  ALTON  CASE 

Inasmuch  as  this  undistributed  surplus  from 
past  earnings  was  mainly  responsible  for  the 
high  price  that  the  purchasers  had  to  pay  for 
the  old  stock  ($175  and  $200  per  share)  they 
naturally  thought  that  they  were  justified 
in  taking  out  of  such  surplus  a  part  of  the  pur- 
chase money.  That  it  belonged  to  them  there 
can  be  no  question.  W.  M.  Ackworth,  the 
leading  European  authority  on  railway  ad- 
ministration, says,  in  a  recent  review  of  Wil- 
liam E.  Hooper's  "Railway  Accounting": 

"Here  in  England  no  one  has  yet  doubted 
that  undivided  profits,  put  back  into  the  busi- 
ness, belong  to  the  shareholders  just  as  much  as 
the  property  purchased  with  the  capital  origi- 
nally subscribed."1 

Halford  Erickson,  a  member  of  the  Railroad 
Commission  of  Wisconsin,  an  authority  not 
likely  to  have  a  pro-railroad  bias,  seems  to 
think  that  it  might  be  expedient  even  to  capi- 
talize past  losses  and  discounts.2  Under  recent 
rulings,  moreover,  of  the  Interstate  Commerce 
Commission,  permanent  betterments  must  be 
charged  to  capital  account,  or  at  least  kept 

iRailway  Age  Gazette,  August  23, 1915. 

2"  Government  Regulation  of  Security  Issues  of  Public  Utility 
Corporations,"  p.  54.    Madison,  Wis.,  January,  1909.  t 

22 


A  MISUNDERSTOOD  TRANSACTION 

separate  from  maintenance  expenses    in  the 
books.1 

In  view  of  these  considerations,  it  is  hard  to 
see  why  it  was  not  proper,  as  it  unquestionably 
was  legal,  to  charge  past  betterments  to  capital 
account  and  declare  a  dividend  of  30  per  cent, 
on  the  old  stock  for  the  purpose  of  lessening 
the  cost  of  the  road  to  its  buyers.  The  only 
reasonable  objections  to  such  a  course  are 
stated,  very  fairly,  by  Professor  Mead  and 
President  Fink.  The  former  is  of  opinion  that 
capitalization  of  sums  previously  spent  for 
betterments  is  justifiable  only  when  the  better- 
ments have  actually  increased  earnings,  which 
in  the  Chicago  &  Alton  case  they  had  not  done. 
"Its  earnings  for  many  years,"  Professor  Mead 
says,  "had  been  stationary/'  and  "its  property 
had  not  been  kept  up  to  standard."  If  the 
company  had  maintained  a  proper  depreciation 
account,  there  would  have  been  no  such  surplus. 
For  these  reasons  he  disapproves  of  the  capital- 
ization of  past  betterments  and  the  issue  of 
bonds  to  pay  a  dividend  thereon;  but  he  admits 
that,  in  the  absence  of  state  legislation  ex- 
pressly forbidding  it,  "the  legality  of  the  pro- 


*W.  M.  Ack worth,  in  Railway  Age  Gazette,  July  23,  191 5.  The 
subject  is  also  discussed  byBeale  and  Wyman  in  their  "Railroad 
Rate  Regulation,"  Sec.  355-362. 

23 


THE  CHICAGO  AND  ALTON  CASE 

ceeding  is  not  to  be  questioned."1  This  judg- 
ment, however,  does  not  change  the  facts  that 
the  money  was  expended,  the  betterments  were 
made,  and  the  cost  might  properly  have  been 
charged,  at  the  time,  to  capital  account.  The 
proceeding  involves  a  question  of  financial  ex- 
pediency, but  not,  in  any  sense,  of  illegality. 

President  Fink  objects  to  the  capitalization 
of  the  cost  of  past  betterments  for  the  reason 
that  it  may  afford  an  opportunity  for  manip- 
ulation of  accounts.2  In  the  Chicago  &  Alton 
case,  however,  no  one  ever  asserted  that  the 
accounts  had  been  tampered  with,  or  that  the 
sum  of  $12,444,000  had  not  actually  been  spent 
for  permanent  betterments.  Both  the  old 
management  and  the  new  recognized  the  past 
expenditures  for  improvement  as  real  and 
legitimate. 

2.  The  issue  of  $31,988,000  of  3  per  cent, 
bonds  to  the  new  stockholders  at  65. 

It  was  perfectly  proper,  and  in  accordance 
with  general  practice,  to  offer  the  new  bonds 
to  the  stockholders  before  offering  them  to 
the  public.  The  stockholders  had  taken  the 
risk  of  putting  $38,815,000  into  the  property, 
and  it  was  only  just  that  they  should  have  the 

1U  Corporation  Finance,"  pp.  246-253. 

2"  Federal  Regulation  of  Railroad  Securities,"  pp.  4-5. 

24 


A  MISUNDERSTOOD  TRANSACTION 

first  chance  to  buy  the  securities  issued  by  the 
company  upon  reorganization.  "But,"  it  may 
be  said,  "the  price  at  which  the  bonds  were 
offered  was  too  low;  it  enabled  the  buyers  to 
resell  them  at  a  great  advance,  and  thus  to 
realize  a  profit  which  ought  to  have  gone  into 
the  treasury  of  the  company."  That  the  stock- 
holders did  make  a  large  profit  when  they 
resold  the  bonds  is  unquestionable;  but  that 
the  price  at  which  they  acquired  them  was  too 
low,  measured  by  the  standards  and  conditions 
of  the  time,  is  not  so  certain.  A  3  per  cent. 
bond  was  then  an  untried  experiment.  The 
bonds  of  the  old  company,  which  were  about  to 
mature,  bore  interest  at  6  and  7  per  cent,  and 
nobody  could  tell  in  advance  what  the  market 
value  of  a  low-rate  security  would  prove  to  be. 
That  the  price  at  which  the  3  per  cent,  bonds 
were  offered  to  the  stockholders  was  low  enough 
to  give  them  a  chance  of  profit  is  true;  but 
there  was  no  intention  of  giving  them  an  exor- 
bitant profit.  A  market  for  bonds  bearing  as  low 
an  interest  rate  as  3  per  cent,  had  to  be  created. 
Such  securities  would  naturally  be  taken  by  sav- 
ings banks;  but  the  bill  making  the  3  per  cent, 
bonds  of  the  Chicago  &  Alton  company  a  legal 
investment  for  the  savings  banks  of  New  York 
had  not  then  passed  the  legislature,  and  it  was 

25 


THE  CHICAGO  AND  ALTON  CASE 

uncertain  whether  it  would  pass.  If  it  did  not, 
the  demand  for  such  bonds  would  be  compara- 
tively limited  and  they  might  not  bring  more 
than  70,  at  which  price  they  would  yield  4.28 
per  cent.  The  bill  which  authorized  savings 
banks  to  invest  in  them  did  not  become  law 
until  February  26,  1900,  more  than  a  year  after 
the  syndicate  bought  the  road.  It  was  then 
signed  by  Theodore  Roosevelt,  governor  of  the 
state,  who  apparently  thought  that  the  bonds 
of  the  "looted,"  "wrecked,"  and  "gutted"  cor- 
poration were  a  safe  investment  for  savings 
banks. 

In  1907,  when  the  Interstate  Commerce 
Commission  investigated  the  subject,  these 
very  bonds  were  selling  for  only  a  little  more 
than  the  price  at  which  they  were  issued,  al- 
though they  were  just  as  good  then  as  they  ever 
had  been.  The  exceptionally  high  prices  from 
which  the  stockholders  profited,  or  may  have 
profited,  in  1901-1902,  were  purely  fortuitous, 
and  were  due  mainly  to  the  state  of  the  money 
market,  the  low  rates  of  interest  which  then 
prevailed,  and  the  unprecedented  demand  for 
investment  securities. 

It  must  not  be  forgotten,  moreover,  that  in 
investing  cash  to  the  amount  of  $20,792,200 
in  3  per  cent,  bonds,  the  stockholders  took  all 

26 


A  MISUNDERSTOOD  TRANSACTION 

the  chances  of  interest  rates,  state  legislation, 
and  savings  bank  demand,  and  that  such  chances 
might  have  gone  against  them.  In  that  case, 
their  bonds  might  have  been  unsalable  and  they 
might  not  have  been  able  to  get  their  money 
back.  They  took  risks  and  reaped  profits, 
and  there  was  little  if  any  criticism  of  their 
action  until  seven  years  later,  when  the  Govern- 
ment, through  the  Interstate  Commerce  Com- 
mission, began  its  campaign  against  that  "un- 
desirable citizen,"  E.  H.  Harriman. 

So  far  as  this  particular  transaction  is  con- 
cerned, the  federal  authorities  might,  with  equal 
reason,  have  begun  proceedings  against  other 
railroad  companies.  In  April,  1899,  the  Chicago, 
Burlington  &  Quincy  sold  to  its  stockholders 
at  75  three-and-one-half-per  cent,  bonds  which 
went  soon  afterward  above  par,  and  some  years 
earlier  the  St.  Paul,  Minneapolis  &  Manitoba 
sold  to  its  shareholders  at  10  an  issue  of  mort- 
gage bonds  which  later  went  above  100.  It 
was  at  that  time  a  frequently  employed  and 
never  contested  practice  to  give  "rights"  to 
stockholders  by  offering  to  them  stocks  or 
bonds  at  prices  below  their  actual  or  possible 
market  value,  and  it  is  still  a  common  practice 
in  other  fields  of  business  enterprise. 

3.  The  alleged  over-capitalization. 
27 


THE  CHICAGO  AND  ALTON  CASE 

The  question  whether  the  Chicago  &  Alton 
Railroad  was  over-capitalized  or  not — that  is, 
whether  its  capital  stock  exceeded  its  value — 
depends  upon  the  definition  given  to  the  word 
"value."  What  is  the  "value"  of  a  railroad? 
To  this  question  three  different  answers  have 
been  given,  namely: 

(a)  The  value  of  a  railroad  is  to  be  measured 
by  the  amount  of  money  actually  invested  in 
it,  from  first  to  last. 

(6)  The  value  of  a  railroad  is  the  present 
cost  of  building  and  equipping  it,  as  new. 

(c)  The  value  of  a  railroad  is  the  sum  on 
which,  as  a  "going  concern,"  it  can  earn  at 
least  the  current  rate  of  interest. 

The  Interstate  Commerce  Commission  seems 
to  prefer  the  first  of  these  definitions;  some 
economists  favor  the  second;  while  most  rail- 
road men  adopt  the  third. 

There  seems  to  be  no  good  reason  for  assum- 
ing that  the  value  of  a  railroad  differs  in  any 
essential  way  from  the  value  of  a  farm  or  a 
factory.  The  value  of  a  farm  is  to  be  ascer- 
tained by  capitalizing  its  annual  net  return 
at  the  current  rate  of  interest.  Two  farms 
may  contain  exactly  the  same  number  of  acres, 
and  may  represent  precisely  the  same  original 
investment,  and  yet  one  may  have  twice  the 
28 


A  MISUNDERSTOOD  TRANSACTION 

value  of  the  other.  If  a  farm,  during  a  series 
of  years,  shows  its  ability  to  earn,  say,  6  per 
cent,  upon  a  capital  of  $10,000,  then  the  value 
of  that  farm  is  $10,000  no  matter  what  its 
original  cost  was.  The  owner  may  have  bought 
it  for  $5,000,  but  it  would  be  manifestly  absurd 
to  say  that  its  value  is  only  $5,000  when  it 
yields  crops  large  enough  to  pay  the  current 
rate  of  interest  on  $10,000.  Its  value  is  to  be 
measured  not  by  the  amount  of  money  originally 
invested  in  it,  but  by  its  earning  capacity  as  a 
"going  concern.,,    The  same  is  true  of  a  factory. 

There  was  once  a  horseshoe  nail  manufactory 
in  northern  New  York  which  was  started  with  a 
capital  of  $100,000.  By  managing  skilfully, 
and  by  gradually  putting  $400,000  of  earnings 
into  new  plant,  improved  machinery,  money- 
saving  inventions,  etc.,  the  owners  finally  made 
it  earn  $300,000  a  year,  or  6  per  cent,  on 
$5,000,000.  Was  the  value  of  that  concern 
the  $500,000  actually  invested  in  it,  or  the 
$5,000,000  on  which  it  could  earn  6  per  cent, 
a  year? 

In  June,  1915,  the  directors  of  the  Ford 
Motor  Car  Company  of  Detroit  increased  the 
capital  stock  of  that  corporation  from  $2,000,000 
to  $100,000,000.  Forty-eight  millions  were 
distributed  in  the  shape  of  a  stock  dividend, 

29 


THE  CHICAGO  AND  ALTON  CASE 

and  the  remaining  stock  was  held  in  reserve 
"for  future  dividends  and  the  development 
of  the  company."1  At  the  time  of  the  increase 
of  capitalization  the  actual  assets  of  the  com- 
pany were  $61,000,000  of  which  only  $24,191,000 
represented  physical  plant.  Suppose  that  in 
future  the  company  is  able  to  earn  6  per  cent. 
on  its  inflated  capitalization  of  $100,000,000. 
What,  then,  will  be  the  value  of  the  manufac- 
tory? Will  it  be  worth  $2,000,000  (the  amount 
of  its  original  capital  stock),  or  $24,191,000 
(the  amount  actually  invested  in  plant),  or 
$61,000,000  (the  amount  of  its  total  assets),  or 
$100,000,000  (the  amount  on  which  it  can  earn 
6  per  cent.)?  In  explaining  the  transaction, 
James  Couzens,  Vice-President  of  the  company, 
said:  "The  purpose  of  the  increase  in  our 
capital  stock  is  to  have  the  outstanding  stock 
more  nearly  represent  the  value  of  the  company" 
— meaning,  of  course,  its  value  as  a  "going 
concern."  If  it  could  earn,  with  regularity 
and  safety,  6  per  cent,  on  its  expanded  capitali- 
zation of  $100,000,000  then  its  value  would  be 
$100,000,000  regardless  of  the  fact  that  its 
original  capital  was  only  $2,000,000  and  re- 
gardless also  of  the  fact  that  its  total  assets  fell 
nearly  $40,000,000  short  of  its  expanded  capital. 

xNew  York  Times  and  New  York  Sun,  June  5  and  20, 1915. 

30 


A  MISUNDERSTOOD  TRANSACTION 

If  the  same  reasoning  is  not  applicable  to  the 
value  of  a  railroad — why  not?  So  far  as  the 
definition  of  "value"  is  concerned,  no  distinc- 
tion can  reasonably  be  made  between  a  rail- 
road and  a  manufactory.  Both  are  to  be  valued 
according  to  their  earning  capacity.  Upon 
this  point  political  economists  generally  are 
agreed.    Prof.  H.  R.  Seager  says: 

"As  an  investment,  land  is  valued,  as  is  any 
other  form  of  income-producing  property,  by 
capitalizing  its  annual  return  at  the  current 
rate  of  interest.  For  example,  if  a  given  piece 
of  land  is  found  by  experience  to  bring  in,  on  an 
average,  a  net  rent  of  $1,200,  and  the  current 
rate  of  interest  is  6  per  cent,  its  price  will 
normally  be  $20,000  or  the  sum  which  invested 
at  6  per  cent,  will  yield  the  same  return."1 

In  considering  the  value  of  a  railroad  as  it 
affects  the  security  of  its  bondholders,  Thomas 
L.  Greene,  Vice-President  of  the  Audit  Com- 
pany of  New  York,  says: 

"The  whole  property  of  a  railroad  company, 
considered  simply  as  real  estate  and  old  material, 
is  worth  but  a  small  fraction  of  the  amount  for 
which  it  is  mortgaged.  The  creditors  of  the 
company  depend  for  their  money  not  upon 

J"  Principles  of  Economics,"  by  H.  R.  Seager,  Professor  of 
Political  Economy  in  Columbia  University;  p.  239. 

31 


THE  CHICAGO  AND  ALTON  CASE 

the  property  considered  as  such,  but  upon  the 
business  for  which  the  company  was  organized; 
that  is,  upon  the  transportation  of  passengers 
and  goods.  If  the  earning  capacity  of  that 
company  becomes  for  any  reason  impaired,  the 
strong  legal  language  of  the  mortgage  will  not 
save  the  holder  of  the  company's  bonds  from 
loss.  In  the  end  he  must  accept,  as  a  basis  for 
the  revaluation  of  his  securities,  the  earning 
power  of  the  company  as  a  carrier  of  traffic."1 

This  whole  question  of  value,  as  it  affects 
railroads,  was  discussed  by  Henry  Fink,  Presi- 
dent of  the  Norfolk  &  Western  Railroad  Com- 
pany, in  a  letter  that  he  wrote  to  the  Railroad 
Securities  Commission  in  1 910,  in  reply  to  their 
request  for  information  and  opinions.  His 
conclusion  was  that  "the  value  of  a  railroad 
can  be  measured  only  by  its  earning  capacity." 
His  judgments,  he  added,  were  based  on  his  own 
experience  during  sixty  years  of  continuous 
railroad  service.2 

This  view  of  railroad  "value"  has  not  only 
been  accepted  by  the  best  economists  and  the 
most  experienced  railway  administrators,  but 
has  repeatedly  been  sanctioned  by  the  courts. 


*"  Corporation  Finance,"  by  Thomas  L.  Greene,  Vice-President 
of  the  Audit  Company  of  New  York;  pp.  35-6  and  $S.    N.  Y.,  1913. 

2"  Federal  Regulation  of  Railroad  Securities  and  Valuation  of 
Railroad  Properties,"  by  Henry  Fink.    Roanoke,  Va.,  1910. 

32 


A  MISUNDERSTOOD  TRANSACTION 

In  the  Oklahoma  case,  Judge  Hook  said:  "An 
established  railroad  system  may  be  worth  more 
than  its  original  cost,  and  more  than  the  mere 
cost  of  its  physical  reproduction."  It  has  no 
value  except  as  a  going  concern.1 

This  also  was  the  view  taken  by  the  U.  S. 
Supreme  Court  in  the  tax  case  of  the  C.  C.  C. 
&  St.  L.  R.  R.  Co.  vs.  Backus.  In  its  opinion 
in  that  case  the  court  said: 

"The  value  of  property  results  from  the  use 
to  which  it  is  put,  and  varies  with  the  profit- 
ableness of  that  use,  present  and  prospective, 
actual  and  anticipated.  There  is  no  pecuniary 
value  outside  of  that  which  results  from  such  use. 
.  .  .  Never  was  it  held  that  the  cost  of  a  thing 
is  the  test  of  its  value.  Suppose  there  be  two 
bridges  over  the  Ohio,  the  cost  of  construction 
of  each  being  the  same,  one  between  Cincinnati 
and  Newport,  and  the  other  twenty  miles  below 
where  there  is  nothing  but  a  village  on  either 
shore.  The  value  of  the  one  will,  manifestly, 
be  greater  than  that  of  the  other,  and  that  excess 
of  value  will  spring  solely  from  the  larger  use 
of  the  one  than  of  the  other."2 

Assuming  then — or,  rather,  adopting  the 
view  of  competent  authorities — that  the  value 

111  Railway  Statistics  of  the  U.  S.,"  by  Slason  Thompson,  p. 
740.    Chicago,  1 9 14. 

2154  U.  S.  445. 

33 


THE  CHICAGO  AND  ALTON  CASE 

of  a  railroad,  and  consequently  its  proper 
capitalization,  should  be  based  on  earning 
capacity,  "present  and  prospective,  actual  and 
anticipated,"  was  Mr.  Harriman  justified  in 
believing  that  he  could  make  the  Chicago  & 
Alton  pay  interest  and  dividends  on  a  capitaliza- 
tion Of  SlOIjOOOjOOO?1 

The  annual  net  income  needed  would  be 
$3,533,44°,  as  follows: 

Interest  on  $40,000,000  3  per  cent,  bonds  .  $1,200,000 
Interest  on  22,000,000  3!  per  cent,  bonds.  770,000 
Dividend  on  19,544,000  preferred  stock  at 

4  per  cent.  .  781,760 
Dividend  on  19,542,000  common  stock  at 

4  per  cent.       .        781,680 

$101,086,000  $3,533,440 

Was  it  prudent  and  reasonable  to  anticipate 
that  when  the  proposed  betterments  should  be 
made,  and  the  necessary  equipment  procured, 
the  greatly  improved  road  would  be  able  to 


1Owing  to  the  necessity  of  spending  for  betterments  four  times 
as  much  as  President  Felton  estimated,  the  capital  stock  was 
later  increased  (upon  the  figuring  of  the  Interstate  Commerce 
Commission)  to  about  $114,000,000,  but  I  am  dealing  here  only 
with  the  original  capitalization  of  $101,000,000  upon  which  Mr. 
Harriman's  calculations  were  based. 

34 


A  MISUNDERSTOOD  TRANSACTION 

earn   the   annual   net  income   of  $3,533,440, 
which  would  be  required?1 

In  the  year  when  the  syndicate  bought  the 
Chicago  &  Alton,  the  road,  even  in  its  run- 
down and  half-equipped  condition,  earned 
$2,684,694  net,  and  it  had  earned,  on  an  average, 
$2,734,534  net,  for  the  six  preceding  years 
(1893  to  1898,  both  inclusive).  It  was  only 
necessary,  therefore,  that  annual  net  earnings 
should  be  increased  by  $798,906  in  order  to 
pay  interest  and  dividends  on  all  outstanding 
securities.  Mr.  Felton,  a  thoroughly  competent 
judge,  estimated  that  by  an  expenditure  of 
$5,200,000  in  betterments  the  annual  net  earn- 
ings of  the  road  might  be  increased  at  least 
$1,000,000.  Mr.  Harriman,  an  even  better 
judge,  believed  that  physical  improvements  and 
good  management  would  bring  the  annual  net 


xSo  far  as  fixed  charges  are  concerned,  the  capitalization  of  the 
Chicago  &  Alton  would  seem  to  have  been  prudent  and  conserva- 
tive. According  to  Prof.  Stuart  Daggett^  the  average  percentage 
of  fixed  charges  to  net  income,  in  seven  railroad  reorganizations 
between  the  years  1893  and  1898  (the  Atchison,  B.  &.  O.,  Erie, 
Nor.  Pac,  Reading,  Southern,  and  Un-Pac.)  was  73.9.  ("Rail- 
road Reorganization,"  p.  358.)  In  the  Chicago  &  Alton,  after 
reorganization,  this  percentage  was  only  72,  and  before  1907  it 
had  fallen  below  60. 

Prof.  E.  S.  Mead  says:  "In  most  cases,  no  more  than  20  per 
cent,  of  the  gross  earnings  of  a  railroad  company  should  be  rep- 
resented by  interest  charges."  ("Corporation  Finance,"  p. 
65.)  After  the  recapitalization  of  the  Chicago  &  Alton,  in  1900, 
the  ratio  of  interest  charges  to  gross  earnings  was  27.5;  but  in 
1907,  on  the  whole  indebtedness  then  outstanding,  it  had  fallen 
below  20. 

35 


THE  CHICAGO  AND  ALTON  CASE 

earnings  up  to  $4,000,000.  How  prudent  and 
conservative  these  estimates  were  the  result 
showed.  In  the  year  when  the  Interstate  Com- 
merce Commission  investigated  the  recapitali- 
zation, the  net  earnings  of  the  road  were 
$4,415,974,  a  sum  which  was  $415,974  above  Mr. 
Harriman's  estimate,  and  $681,440  above  the 
estimate  of  Mr.  Felton.  If  rates  had  not  been 
reduced  during  the  period  of  Mr.  Harriman's 
administration,  the  increase  in  net  earnings 
would  have  been  even  greater  than  this.1 


xThe  reduction  of  ton-mile  freight  rates  between  1899  and  1907 
is  given  by  the  Director  of  the  Bureau  of  Railway  Statistics  as 
follows: 

Receipts  per  ton-mile 
Year  (in  cents) 

1899 800 

1900 796 

1901 723 

1902 679 

1903 599 

1904  •     • 677 

1905 689 

1906 639 

1907 604 

A  part  of  this  reduction,  but  according  to  Mr.  Thompson  only 
a  small  part,  was  due  to  the  development  of  a  large  coal  traffic, 
on  which  the  rates  were  low;  but  in  commenting  on  the  figures 
the  Director  says: 

"Whatever  may  be  the  popular  impression  as  to  the  over- 
capitalization of  the  Alton,  the  above  table  furnishes  proof  that 
it  had  no  effect  whatever  in  causing  exorbitant  rates,  for  these 
are  nearly  25  per  cent,  lower  than  in  1899."  ("Cost,  Capitali- 
zation and  Estimated  Value  of  American  Railways,"  by  Slason 
Thompson,  Director  of  Bureau  of  Railway  Statistics,  pp.  186-187. 
Chicago,  1907.) 


36 


A  MISUNDERSTOOD  TRANSACTION 

A  case  parallel  in  some  respects  to  that  of  the 
Chicago  &  Alton  is  furnished  by  the  reorgani- 
zation of  the  Norfolk  &  Western  Railroad  in 
1896.  In  1895,  before  the  reorganization  and 
recapitalization,  the  road  and  equipment  were 
valued  at  $115,098,721  and  the  capitalization 
was  $117,364,909  as  follows: 

Bonds $  57,864,909 

Preferred  stock 50,000,000 

Common  stock 9,500,000 

Total  capitalization    ....     $117,364,909 

In  the  reorganization,  the  bonds  were  in- 
creased by  $4,635,000  and  the  common  and 
preferred  stock  by  $30,000,000,  making  an  ex- 
panded capitalization  of  $151, 999,909.*  In 
commenting  upon  this  inflation,  which  amounted 
as  above  shown  to  nearly  $35,000,000,  President 
Fink  said:  "Stocks  issued  in  such  cases  are  in 
no  sense  fictitious.  They  represent  actual  values, 
and  are  drafts,  for  value  received,  on  more  pros- 
perous times." 

He  then  shows  that  although  the  Norfolk  & 
Western  was  over-capitalized  in  1896,  in  the 
sense  that  it  was  not  then  earning  dividends  and 
fixed  charges,  it  did  begin  paying  dividends  on 
its  preferred  stock  in  1897,  and  on  its  common 

^Commercial  and  Financial  Chronicle,  Vol.  LXII,  1896. 

37 


THE  CHICAGO  AND  ALTON  CASE 

in  1901.1  Its  stock  is  now  quoted  at  119,  which 
shows  that  its  earning  power  has  much  more 
than  overtaken  its  expanded  capitalization. 

Mr.  Harriman  expected  to  do  with  the  Chi- 
cago &  Alton  just  what  Mr.  Fink  did  with  the 
Norfolk  &  Western,  viz.,  increase  by  means  of 
extensive  betterments  its  capacity  for  doing 
business  and  its  earning  power,  and  thus  bring 
its  net  operating  revenue  up  to  the  requirements 
of  its  enlarged  capitalization.  That  he  measur- 
ably succeeded  in  doing  this  is  shown  by  the 
fact  that  when,  after  losing  control  of  the  road 
in  1903,  he  completely  severed  his  connection 
with  it  in  1907,  it  was  paying  4  per  cent,  on  its 
preferred  stock  and  earning  5  per  cent,  on  its 
common.  In  other  words,  it  was  taking  care 
of  its  entire  capitalization,  and  was  doing  this 
with  no  increase  of  rates  and  with  an  enormous 
extension  of  its  facilities  for  doing  business  and 
serving  the  public. 

All  these  facts,  however,  were  suppressed  or 
ignored  in  the  Interstate  Commerce  Commis- 
sion's report.  The  Commissioners,  from  their 
point  of  view,  might  have  been  justified  in  ex- 
pressing disapproval  of  Mr.  Harriman's  financial 
methods;  but  they  were  not  justified  in  con- 

v< Over-capitalization,"  by  Henry  Fink;  Railway  Age  Gazette, 
July,  1908. 

38 


A  MISUNDERSTOOD  TRANSACTION 

cealing  the  fact  that  these  methods  had  more 
than  doubled  the  capacity  of  the  road  to  serve 
the  people.  "Suppressio  veri  suggestio  falsi," 
and  the  concealment  in  this  case  gave  the  im- 
pression that  Mr.  Harriman — in  the  words  of 
Senator  Cullom — had  "looted  the  road,"  re- 
gardless of  the  interests  of  the  people  and  the 
territory  that  it  served.  The  rebuilding  of 
the  Chicago  &  Alton  was  one  of  the  great  rail- 
road achievements  of  the  time;  but  in  the  report 
of  the  Commission  it  is  made  to  appear  a  pirati- 
cal raid  of  unscrupulous  financiers,  who,  for 
their  own  selfish  purposes,  wrecked  and  looted 
a  well-conducted  and  prosperous  corporation. 
If  the  members  of  the  Commission  could  be 
put  on  the  witness  stand,  as  Mr.  Harriman  was, 
and  could  be  required,  under  oath,  to  tell  "the 
whole  truth,"  they  might  find  it  difficult  to 
explain  why,  in  a  report  that  was  supposed  to 
cover  all  the  facts  essential  to  an  understanding 
of  the  case,  they  said  nothing  with  regard  to 
the  physical  condition  of  the  Alton  road  when 
the  syndicate  bought  it;  nothing  about  the 
intention  of  the  old  managers  to  declare  just 
such  a  dividend  as  that  declared  later  by  the 
new  managers;  nothing  about  the  sanction 
given  by  courts  and  legal  authorities  to  the 
capitalization    of   past   betterments;    nothing 

39 


THE  CHICAGO  AND  ALTON  CASE 

about  the  practice  of  the  time  in  the  matter  of 
reorganizations;  nothing  about  Mr.  Harriman's 
virtual  reconstruction  and  reequipment  of  the 
road;  nothing  about  the  increase  of  90  per 
cent,  in  gross  earnings  and  80  per  cent,  in  net 
earnings  which  resulted  therefrom;  nothing 
about  the  benefit  that  the  public  derived  from 
the  lowering  of  rates  and  the  improvement  of 
facilities;  nothing  about  the  relation  between 
the  earning  capacity  of  the  reorganized  road 
and  its  expanded  capitalization;  and  nothing 
about  the  resumption  of  dividends  on  the  pre- 
ferred stock  in  1906.  A  report  which  conceals 
or  ignores  these  pertinent  facts  is  not  a  judicial 
review  of  the  case,  but  merely  a  prosecuting 
attorney's  brief. 

The  responsibility  for  the  present  condition 
of  the  Chicago  &  Alton  cannot  justly  be  thrown 
upon  Mr.  Harriman.  The  control  of  the  road 
was  wrested  from  him  by  the  Rock  Island, 
while  he  was  in  Europe  in  1903,  and  he  severed 
his  relation  with  it  altogether  when  the  Rock 
Island  transferred  its  holdings  to  the  Toledo, 
St.  Louis  &  Western  in  1907.  The  financial 
measures  adopted  by  the  later  management 
were  ill-advised  and  unfortunate,  and  never 
would  have  met  Mr.  Harriman's  approval. 
Partly  to  these  measures,  and  partly  to  regula- 
40 


A  MISUNDERSTOOD  TRANSACTION 

tion,  low  rates,  and  depressed  business  condi- 
tions, the  present  difficulties  of  the  road  are  due. 
When  Mr.  Harriman  resigned,  it  was  not  only- 
paying  its  fixed  charges,  but  was  earning  more 
than  4  per  cent,  on  both  classes  of  its  stock. 

Before  concluding  this  review  of  the  Chicago 
&  Alton  reorganization,  it  seems  necessary  to 
answer  specifically  certain  charges  made  against 
Mr.  Harriman  by  two  men  who  occupy  posi- 
tions of  responsibility  or  authority,  namely: 
Interstate  Commerce  Commissioner  Prouty  and 
Prof.  William  Z.  Ripley  of  Harvard  University. 

In  an  address  delivered  before  the  National 
Association  of  Manufacturers,  in  May,  1907, 
Commissioner  Prouty  said: 

"When  Mr.  Harriman,  by  dealings  like  those 
in  the  Chicago  &  Alton,  enriches  himself  to  the 
extent  of  many  millions,  he  has  not  created  that 
money.  He  has  merely  transferred  it  from  the 
possession  of  some  one  else  to  himself."1 

In  the  first  place,  there  is  no  evidence  to  show 
that  Mr.  Harriman,  as  an  individual  participant 
in  a  syndicate  of  one  hundred  members,  en- 
riched himself  to  the  extent  of  "many  millions.' ' 
In  the  second  place,  it  may  controversially  be 
said  that  when  the  Interstate  Commerce  Com- 


*New  York  Independent,  May  30,  1907,  p.  11 29. 
41 


THE  CHICAGO  AND  ALTON  CASE 

missioners,  by  drawing  money  in  the  shape  of 
salaries  from  the  people  of  the  United  States, 
enrich  themselves  to  the  extent  of  many  hun- 
dreds of  thousands  of  dollars,  they  have  not 
created  that  money.  They  have  merely  trans- 
ferred it  from  the  possession  of  some  one  else 
to  themselves.  They  may  reply  that  for  the 
money  they  have  thus  transferred  from  the 
people  of  the  United  States  to  themselves, 
through  the  United  States  Treasury,  they  have 
rendered  valuable  services — in  other  words, 
they  have  earned  it.  Mr.  Harriman  might 
have  said  the  same,  and  with  much  more  reason. 
By  his  "dealings"  in  the  Chicago  &  Alton  he  al- 
most entirely  rebuilt  the  road;  doubled  its  pas- 
senger accommodations;  improved  immensely 
its  train  service;  increased  by  134  per  cent, 
the  hauling  power  of  its  locomotives;  added 
269  per  cent,  to  its  capacity  for  moving  freight; 
fostered  old  industries  and  created  new  ones 
all  along  its  line,  and  enabled  the  people  of 
Illinois  to  "create"  tens  of  millions  of  dollars 
which  they  never  could  have  created  without 
the  traffic  facilities  given  them  by  Mr.  Harri- 
man's  betterments.  If  the  Interstate  Com- 
merce Commissioners  could  show  anything  like 
this  equivalent  for  the  money  they  have  "trans- 
ferred" from  the  United  States  Treasury  to 

42 


A  MISUNDERSTOOD  TRANSACTION 

themselves,  their  claim  to  have  earned  their 
salaries  would  be  unquestioned  and  unques- 
tionable. Unfortunately,  in  the  judgment  of 
many  thinking  people,  they  have  injured  the 
business  of  the  country  instead  of  promoting 
it,  and  by  their  cramping  over-regulation  of 
railroads  have  frightened  away  capital,  and 
have  thus  prevented  the  construction  of  thou- 
sands of  miles  of  new  road,  which  the  country 
already  needs,  and  will  need  still  more  urgently 
in  the  near  future.  In  the  judgment  of  many 
competent  observers  they  have  also  forced  into 
bankruptcy  dozens  of  railroads  which  were  not 
mismanaged,  and  which  might  have  met  all 
their  obligations  if  they  had  been  allowed  to 
make  their  rates  high  enough  to  cover  increased 
taxes,  increased  wages,  and  the  largely  increased 
cost  of  materials  and  equipment.  Eighty-two 
railway  corporations  are  now  in  the  hands  of 
receivers,  and  even  Mr.  Prouty  will  hardly 
contend  that  they  have  all  been  "wrecked," 
"looted,"  or  financially  mismanaged  by  un- 
scrupulous speculators.  Most  of  them  have 
failed  simply  because  the  policy  of  the  Inter- 
state Commerce  Commission  has  impaired  the 
credit  of  railway  corporations  generally,  and 
made  it  impossible  for  weak  roads  to  sell  their 
securities  on  advantageous  terms.    Investors 

43 


THE  CHICAGO  AND  ALTON  CASE 

will  not  buy  such  securities  until  they  have  a 
reasonable  assurance  that  the  Commission  will 
permit  the  companies  to  earn  fixed  charges  and 
dividends.  It  seems,  therefore,  to  be  at  least  a 
debatable  question  whether  the  Commission 
has  not  wrecked  more  railroads  than  the  un- 
scrupulous financiers  have. 

One  of  the  most  unfair,  as  well  as  one  of  the 
most  recent,  of  Mr.  Harriman's  assailants  is 
Prof.  William  Z.  Ripley,  Ropes  Professor 
of  Economics  in  Harvard  University.  In  a 
volume  entitled  "Railroads:  Finance  and  Or- 
ganization," published  by  Longmans  Green 
&  Co.  of  N.  Y.,  in  191 5,  Professor  Ripley  devotes 
a  large  part  of  his  eighth  chapter  to  the  Chicago 
&  Alton  reorganization,  and  begins  his  account 
of  it  in  the  following  words: 

"Practically  all  of  the  possible  abuses  and 
frauds  described  in  the  preceding  pages  under 
the  caption  of  stock-watering  are  found  com- 
bined in  a  single  instance  in  recent  years — the 
reorganization  of  the  Chicago  &  Alton  road  by 
the  late  E.  H.  Harriman  and  his  associates 
during  the  eight  years  following  1898."1 

Most  of  the  hostile  critics  of  the  Chicago  & 
Alton  transaction  try  to  make  their  points  by 

Chapter  VIII,  p.  262. 

44 


A  MISUNDERSTOOD  TRANSACTION 

concealing  or  ignoring  facts  favorable  to  the 
defence.  Professor  Ripley  not  only  conceals  or 
ignores,  but  misstates.  He  says,  for  example, 
that  the  Chicago  &  Alton  road,  prior  to  the 
reorganization,  was  doing  "a  constantly  ex- 
panding business."  This,  simply,  is  not  true. 
The  gross  earnings  of  the  road  had  decreased 
more  than  $2,500,000  in  the  eleven  years  that 
preceded  the  change  of  ownership.  In  1887 
they  were  nearly  $9,000,000,  while  in  1898,  the 
year  before  the  Harriman  syndicate  acquired 
the  property,  they  had  fallen  to  $6,286,568. 
A  business  which  declines  to  the  extent  of 
$2,655,000  in  a  little  more  than  a  decade  may 
still  continue  to  be  a  profitable  business,  but 
it  certainly  is  not  "a  constantly  expanding  busi- 
ness."1 


JProf.  E.  S.  Mead,  who  is  a  much  more  careful  and  trustworthy 
student  of  railroad  affairs  than  Professor  Ripley  seems  to  be, 
states  the  fact  accurately  when  he  says  ("Corporation  Finance," 
p.  251):  "The  earnings  of  the  Chicago  &  Alton,  prior  to  the  reor- 
ganization, had  been  stationary  for  many  years."  They  had 
been  stationary  for  about  five  years,  but  had  decreased  30  per 
cent,  in  eleven  years.  The  precise  figures  are  given  by  Director 
Thompson  of  the  Bureau  of  Railway  Statistics  as  follows: 

Year  Gross  earnings 

1887 $8,941,386 

1888 7,511,465 

1889 7,516,616 

1890 7,065,753 

1891 7,590,881 

1892 7,73o,6io 

1893 7,566,640 

1894 6,292,236 

45 


THE  CHICAGO  AND  ALTON  CASE 

Professor  Ripley  states  repeatedly  (pp.  264- 
265)  that  the  operations  of  Mr.  Harriman  and 
the  syndicate  were  "covered  up,"  "remained 
undisclosed,"  "were  never  disclosed,"  "were 
obscured  in  the  published  accounts,"  and  "were 
thoroughly  concealed."  This,  again,  is  simply 
not  true.  All  the  operations  of  Mr.  Harriman 
and  the  syndicate,  including  the  capitalization 
of  past  betterments,  the  declaration  of  a  30  per 
cent,  dividend,  and  the  sale  of  the  3  per  cent, 
bonds  to  the  stockholders  at  65,  were  fully  and 
accurately  set  forth  in  the  listing  application 
to  the  New  York  Stock  Exchange,  as  well  as 
in  the  leading  railroad  and  financial  publications 
of  New  York,  including  Poor's  Manual,  Moody's 
Manual,  the  Manual  of  Statistics,  the  Com- 
mercial and  Financial  Chronicle,  the  Wall 
Street  Journal,  and  the  New  York  Evening 
Post} 


1895 $6,292,486 

1896 6,840,283 

1897 6,673,605 

1898 6,286,568 

("Cost,  Capitalization,  and  Estimated  Value  of  American  Rail- 
ways," by  Slason  Thompson,  Director  of  the  Bureau  of  Railway 
Statistics;  p.  183.    Chicago,  1907.) 

xPoor's  Manual  for  1900,  pp.  654  and  657,  and  for  1901,  pp. 
661-2.  Moody's  Manual  for  1901,  p.  1195.  Manual  of  Statistics 
for  1900,  p.  61,  and  for  1901,  p.  59.  Commercial  and  Financial 
Chronicle  in  the  five  numbers  for  April  7  and  14;  May  5  and  19; 
and  November  17, 1900. 

46 


A  MISUNDERSTOOD  TRANSACTION 

In  commenting  upon  this  feature  of  the  case, 
in  a  statement  written  in  1907  but  never  pub- 
blished,  Mr.  Harriman  said: 

"Every  essential  fact  connected  with  the 
recapitalization  of  the  Chicago  &  Alton  system, 
including  the  objects  for  which  the  new  securi- 
ties were  issued,  was  fully  disclosed  and  widely 
published,  at  the  time,  in  circulars,  financial 
papers,  annuals,  and  reference  books  for  invest- 
ors, etc.,  etc.  These  publications,  as  well  as 
the  printed  applications  to  the  New  York 
Stock  Exchange,  showed  exactly  for  what  con- 
sideration each  class  of  securities  had  been 
issued,  including  the  fact  that  the  refunding  3 
per  cent,  bonds  of  the  railroad  company  had 
been  subscribed  for  by  the  stockholders  at 
65,  and  that  a  dividend  of  30  per  cent,  had  been 
declared  in  May,  1900.  The  listing  committee 
of  the  Exchange  investigated  fully,  and  unani- 
mously recommended  the  granting  of  official 
quotations  to  all  the  securities  and  their  ad- 
mission to  dealings  on  the  Exchange.  This 
recommendation  was  approved,  without  any 
dissenting  voice,  by  the  Board  of  Governors  of 
the  Exchange,  consisting  of  forty  members  of 
high  standing.  So  far  as  I  know,  there  has 
never  been  the  slightest  pretence  that  any  of  the 
original  stockholders  were  deceived  in  any 
manner  or  form,  or  that  any  subsequent  invest- 
or was  in  any  way  misled.  All  parties  in 
interest  have  acquiesced,  for  seven  years,  with 

47 


THE  CHICAGO  AND  ALTON  CASE 

full  knowledge.  The  transaction  is  now  criti- 
cised, for  the  first  time,  and  in  a  manner  cal- 
culated to  misrepresent  and  distort  the  facts 
as  they  existed  in  1900  when  the  securities  were 
created  and  issued." 

Mr.  Harriman's  statement,  supported  though 
it  be  by  all  the  railroad  manuals  and  financial 
journals  of  New  York,  may  fail  to  carry  con- 
viction to  as  biassed  a  mind  as  that  of  Professor 
Ripley;  but  it  will  be  generally  accepted  by 
people  who  are  more  desirous  of  knowing  the 
truth  than  of  making  out  a  case  against  the 
Chicago  &  Alton  syndicate. 

Professor  Ripley  accuses  Mr.  Harriman  of 
"prejudicing  the  interest  of  shippers  by  creat- 
ing the  need  of  high  rates  for  service  in  order  to 
support  the  fraudulent  capitalization."  (p. 
262.)  This  charge  is  doubly  misleading.  In 
the  first  place,  it  erroneously  assumes  that 
rates  are  dependent  upon  capitalization,  and 
in  the  second,  it  suggests  that,  as  a  matter  of 
fact,  Mr.  Harriman  did  raise  rates  on  the  Alton 
in  order  to  bolster  up  fictitious  securities. 
Neither  the  assumption  nor  the  suggestion  is 
supported  by  the  facts. 

High  capitalization,  as  a  rule,  does  not  result 
in  high  rates.  On  the  contrary,  the  lowest 
average  freight  rates  are  in  the  parts  of  the 

48 


A  MISUNDERSTOOD  TRANSACTION 

United  States  that  have  the  highest  railroad 
capitalization.1  That  there  is  no  interdepend- 
ence of  capitalization  and  rates  has  been  re- 
peatedly admitted  even  by  the  Interstate  Com- 
merce Commission.  As  long  ago  as  1899 
Chairman  Martin  A.  Knapp  testified  before  the 
Industrial  Commission  that  he  had  never  seen 
a  case  in  which  rates  seemed  to  depend  upon 
capitalization,  or  to  be  influenced  by  it.  "The 
capitalization  of  a  railroad,"  he  said,  "cuts  no 
figure  in  this  rate  question." 

In  an  article  entitled  "Railroad  Capitali- 
zation and  Federal  Regulation,"  Franklin  K. 
Lane,  while  he  was  yet  Commissioner,  said: 
"Fundamentally  there  is  no  interdependence  of 
capitalization  and  rate.  The  latter  is  not  in  law, 
nor  in  railroad  policy,  the  child  of  the  former.' ' 

Mr.  Harriman,  who  had  a  much  clearer 
understanding  of  the  principles  of  rate-making 
than  the  Harvard  Professor  of  Economics  seems 
to  have,  said  in  the  unpublished  statement 
previously  quoted: 

"It  is  just  as  impossible  to  raise  rates  to  any 
level  that  may  be  necessary  to  pay  charges  on 
increased  capitalization  as  it  would  be  for  a 

x"The  Railroad  Situation  of  To-day,"  by  Frank  Trumbull: 
An  Address  to  the  Western  Society  of  Engineers,  January  5, 
1909,  p.  7. 

49 


THE  CHICAGO  AND  ALTON  CASE 

manufacturer  of  steel,  or  of  woolens,  or  of  any 
other  commodity,  to  raise  his  prices  because  he 
had  a  large  debt  upon  which  it  was  necessary 
to  pay  interest,  or  a  large  capital  employed  in 
the  business.  It  would  be  suicidal  for  a  railroad 
company  to  throttle  or  paralyze  the  industries 
along  its  lines  by  charging  exorbitant  rates. 
Even  if  there  be  no  direct  competition  by  parallel 
roads,  every  industrial  plant  located  along  a 
line  of  railroad  is  competing  with  plants  located 
on  other  lines,  and  every  railroad  is  forced  to 
make  such  low  and  reasonable  rates  as  will 
permit  the  industries  in  the  territory  tributary 
to  it  to  make  sales  in  competitive  markets,  and 
thus  furnish  the  traffic  from  which  the  railroad 
company  derives  its  earnings.  It  is  impossible 
for  a  railroad  company  to  sever  its  interests 
from  those  of  its  patrons.  Its  life  blood  is 
drawn  from  their  prosperity,  and  it  must  furnish 
them  with  adequate  and  ever-increasing  facili- 
ties at  reasonable  rates,  wholly  irrespective  of 
its  capitalization.  If  the  calculations  of  the 
organizers  of  a  railroad  company  turn  out  to  be 
erroneous,  and  the  capitalization  is  fixed  at  too 
high  a  figure,  it  is  a  misfortune  for  them  and  the 
other  security  holders;  but  the  wide-spread 
popular  impression  that  a  railroad  company  can 
extort  money  from  the  public  at  will,  and  in 
defiance  of  the  laws  of  trade,  simply  for  the 
purpose  of  paying  interest  or  dividends  upon 
increased  issues  of  securities,  is  not  justified  by 
the  facts." 

So 


A  MISUNDERSTOOD  TRANSACTION 

In  this  brief  statement  there  is  more  financial 
and  economic  wisdom,  perhaps,  than  in  a  dozen 
volumes  of  Interstate  Commerce  Commission 
reports,  and  more  even  than  in  some  Supreme 
Court  decisions. 

The  statement  that  the  "unscrupulous  man- 
agement "  of  the  Chicago  &  Alton  did,  as  a 
matter  of  fact,  "increase  rates  for  service  in 
order  to  support  the  fraudulent  capitalization" 
is  not  true.  The  freight  records  of  the  Chicago 
&  Alton  for  the  period  in  question  show  a  slight 
reduction  in  rates  on  grain,  live-stock,  merchan- 
dise, and  other  classified  commodities,  with  a 
very  substantial  reduction  on  coal.  In  1899 
the  through  rate  on  coal  from  the  Springfield 
district  was  80  cents.  In  1907  it  fell  as  low  as 
40  cents.  The  average  rate  per  ton  per  mile 
on  the  whole  traffic  (including  coal)  was  re- 
duced, as  Slason  Thompson  has  shown,  about 
25  per  cent.  The  precise  figures  have  been 
given  on  a  previous  page. 

The  most  surprising  of  all  Professor  Ripley's 
misstatements  is  that  which  charges  Mr.  Har- 
riman  with  "crippling"  the  Alton  road  "physi- 
cally." (p.  262.)  Mr.  Frank  H.  Spearman, 
who  made  the  rebuilding  of  the  Chicago  & 
Alton  the  subject  of  a  special  article,  described 
the  "crippling"  process  in  the  following  words: 

5i 


THE  CHICAGO  AND  ALTON  CASE 

"Without  delay  or  hesitation  he" — (Mr. 
Harriman) — "set  about  making  of  the  Alton 
the  best  possible  road  of  its  class,  and  its  class 
is  the  first.  He  overhauled  the  system  com- 
pletely, and  put  it  physically  a  little  in  advance 
of  every  competitor.  To  instance:  For  thirty 
years  the  Alton  had  been  strong  in  a  territory 
possessing  the  richest  coal  deposits  in  Illinois, 
and  not  until  the  Harriman  forces  took  hold  of 
the  road  had  it  ever  developed  a  coal  business. 
Not  only  has  the  new  Alton  been  equipped  with 
what  it  never  had  before,  cars  and  motive  power 
to  handle  this  traffic,  but  its  engineers,  in  re- 
building the  line,  show  the  lowest  maximum 
grades  from  the  Illinois  coal  fields  into  Chicago. 
Beginning  with  nothing,  the  new  owners  have, 
within  five  years,  developed  a  coal  traffic  that 
already  ranks  second  in  volume  among  the  soft- 
coal  roads  of  its  territory.  .  .  .  The  Alton 
being  once  acquired,  it  became  the  policy  of  the 
new  owners  to  increase  the  facilities  of  the  public 
along  their  line  for  doing  business.  .  .  . 
The  heaviest  freight  engines  previously  owned 
had  been  of  fifty-five  tons,  and  were  capable, 
in  condition,  of  hauling  thirty  cars,  of  twenty- 
five  tons  each;  but  the  engines  had  been  allowed 
to  deteriorate  until  not  above  80  per  cent, 
of  that  capacity  could  be  obtained.  The  new 
engines,  of  the  consolidation  type,  for  freight 
traffic,  weigh  one  hundred  and  sixty-five  tons 
and  haul  one  hundred  freight  cars.  The  pas- 
senger power  consisted  of  forty-  to  fifty-ton 

52 


A  MISUNDERSTOOD  TRANSACTION 

engines,  capable  of  hauling  five  to  seven  coaches 
of  their  day  at  high  speed.  Such  engines  have 
been  replaced  by  modern  engines  of  one  hundred 
and  thirty-five  tons,  while  for  especially  heavy 
passenger  service,  of  which  the  road  has  more 
than  any  line  in  its  territory,  exceptionally  large 
engines  have  been  provided,  recent  additions 
including  the  two  most  powerful  express  pas- 
senger engines  in  the  world.  ...  In  freight 
car  equipment,  twenty-  and  twenty-five-ton 
capacity  wooden  gondola  cars  were  replaced  by 
fifty-five-ton  capacity  steel  gondolas,  and  the 
proportion  of  the  weight  of  car  to  load  was 
reduced  one  third  at  a  stroke.  Acquiring  a 
line  that  had  always  enjoyed  a  heavy  passenger 
traffic,  the  new  owners,  where  they  had  found 
fifty-feet  coaches,  built  coaches  seventy  feet 
long,  and  by  ingeniously  installing  seats  of  a 
modern  type,  as  well  as  more  comfortable  than 
those  of  earlier  models,  they  have  succeeded  in 
accommodating  in  the  new  cars  twice  the  num- 
ber of  passengers  provided  for  in  the  old.  .  .  . 
"What  it  means  to  make  over  a  railroad  for 
such  modern  traffic  requirements  is  reflected 
sharply  in  the  work  put  upon  the  construction 
department.  Working  out  of  Chicago,  track 
elevation  was  pushed  until  every  railroad  grade- 
crossing,  from  the  terminal  station  to  the  su- 
burban yards,  has  been  eliminated.  The  grades 
receiving  the  heaviest  of  the  traffic,  as  it  centred 
toward  Chicago,  were  reduced  until  they  gave 
the  rebuilt  road  the  lowest  maximum  grade  of 

53 


THE  CHICAGO  AND  ALTON  CASE 

any  road  entering  Chicago  from  the  western 
coal  fields.  At  the  very  outset  the  work  of 
double-tracking  was  begun.  To  provide  for 
heavy  cars  and  engines,  heavier  rails  have  been 
spread  south  and  west  until  to-day  over  one 
half  the  total  mileage  of  the  entire  system  shows 
new  steel.  The  work  falling  on  the  bridge 
department  was  continuous  and  exacting.  While 
shops  were  being  enlarged,  engine-houses  re- 
built, and  turn-tables  lengthened,  the  track 
elevation  at  Chicago  called  unceasingly  for 
viaducts,  and  the  traffic  conditions  everywhere 
on  the  system  demanded  new  bridges  for  the 
motive  power.  ...  On  less  than  a  thou- 
sand miles  of  trackage  three  hundred  and 
eighteen  bridges  were  replaced  within  four  years. 
Of  these,  one  hundred  and  fourteen  bridges 
were  wholly  done  away  with  by  the  cast-iron 
pipe  and  the  concrete  arch — the  progress  in 
the  use  of  concrete  work  being  one  of  the  most 
striking  features  of  recent  bridge  construction. 
But  besides  the  great  bridge  across  the  Missouri" 
— (the  old  million-dollar  steel  bridge  was 
"scrapped") — "and  four  solid-floor  creosoted 
trestles,  one  hundred  and  twenty-two  steel 
bridges  also  were  installed. 

"The  elimination  of  curvature,  pushed  till 
the  maximum  had  been  reduced  to  four  degrees, 
is  still  in  progress,  and  so  far  has  bad  curvature 
been  taken  care  of  that  an  engineman  familiar 
with  a  division  five  years  ago  would  hardly 
recognize  the  right  of  way  in  the  daylight. 

54 


A  MISUNDERSTOOD  TRANSACTION 

Long  restful  stretches  of  straight  track  have 
been  developed  until  there  are  now  on  the 
system  many  tangents  of  from  fifteen  to  twenty 
miles;  there  is  at  least  one  tangent  of  twenty- 
nine  miles;  and  one  extraordinary  stretch  of 
forty-five  miles  of  track,  straight  as  an  arrow's 
flight.  ...  To  strengthen  the  work  of  the 
operating  department,  the  railroad  world  has 
been  drawn  upon  for  the  most  effective  safety 
devices  in  the  operation  of  trains.  Long 
stretches  of  track,  in  one  instance  covering  a 
distance  of  sixty-five  miles,  are  provided  with 
continuous  electric  signals  which  protect  moving 
trains,  stations,  grades,  and  curves.  Previously 
to  the  rebuilding  there  were  comparatively  few 
interlocking  signals  on  the  whole  line  to  protect 
railroad  grade-crossings."1 

According  to  Professor  Ripley,  the  nefarious 
purpose  of  the  "main  conspirator"  in  making  all 
these  improvements  was  to  "cripple"  the  road 
"physically!" 

During  the  period  of  Mr.  Harriman's  ad- 
ministration he  spent  $11,262,763  on  roadway 
and  structures,  and  $11,064,454  on  new  equip- 
ment, making  a  total  of  $22,327,219  for  per- 
manent betterments,  a  sum  equivalent  to  about 
$22,000  per  mile.    The  road  thus  "physically 

x"The  Rebuilding  of  an  American  Railroad,"  by  Frank  H. 
Spearman  (in  "The  Strategy  of  Great  Railroads"),  pp.  50^  223, 
225-226.  N.  Y.,  1914.  This  article  was  originally  published 
before  the  work  of  rebuilding  had  been  finished. 

55 


THE  CHICAGO  AND  ALTON  CASE 

crippled' '  increased  its  gross  earnings  from 
$6,286,569  in  1898  to  $12,809,426  in  1907,  and 
its  net  earnings  from  $2,684,694  to  $4,415,974. 
How  it  was  able  to  do  this,  in  its  "physically 
crippled"  condition,  Professor  Ripley  does  not 
explain. 

Those  who  have  made  a  serious  study  of  Mr. 
Harriman's  activities  know  that  he  never 
"physically  crippled"  a  railroad  in  his  life.  On 
the  contrary,  he  never  touched  a  railroad  that 
he  did  not  physically  improve.  From  the  Sodus 
Bay  &  Southern  to  the  Union  Pacific  and  the 
Alton,  he  made  every  railroad  that  he  controlled 
serve  the  public  better  than  it  had  ever  served 
it  before.  No  railroad  corporation,  moreover, 
ever  defaulted  on  its  bonds,  or  failed  to  earn  its 
fixed  charges,  under  Mr.  Harriman's  man- 
agement.1 

It  is  not  easy  to  characterize  Professor  Rip- 
ley's statements  fittingly  without  overstepping 
the  bounds  of  controversial  courtesy;  but 
inasmuch  as  he,  himself,  has  not  hesitated  to  call 
Mr.  Harriman  a  "conspirator,"  and  to  describe 
his  management  of  the  Chicago  &  Alton  as 
"unscrupulous,"  "piratical,"  "fraudulent,"  and 
"predatory,"  it  may  perhaps  be  proper  to  say, 

hearings  before  the  Interstate  Commerce  Commission  in  the 
Chicago  &  Alton  Case,  p.  73. 

56 


A  MISUNDERSTOOD  TRANSACTION 

in  the  form,  although  not  quite  in  the  words,  of 
the  professor's  opening  sentence: 

"Practically  all  of  the  possible  methods, 
described  in  previous  pages,  of  making  a  thing 
seem  that  which  it  is  not,  are  found  combined 
in  a  single  instance  in  recent  years — the  ac- 
count of  the  reorganization  of  the  Chicago  & 
Alton  Railroad  by  William  Z.  Ripley,  Ropes 
Professor  of  Economics  in  Harvard  University." 


57 


THE   COUNTRY  LIFE   PRESS 
GARDEN  CITY,  N.  Y. 


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